Macroeconomics Book by Gregory Mankiw

How much labour does the firm hire?

- The point at which the change in revenue is equal to the change in wages. (ΔProfit = 0) ΔRevenue - ΔWages = 0 P x MPL - W = 0 MPL = W/P.

What is the relationship between investment and real interest rate?

- The quantity of investment is inversely proportional to real interest rate. As real interest rate increases, The investment decreases. - I = I(r), (Investment is a function of real interest)

Nominal interest rate (definition)

- The return to saving and the cost of borrowing without adjustment for inflation. - The rate of interest that investors pay to borrow money.

Which adjustments take us from National Income to Personal Income?

1) Subtract taxes on production and imports (indirect business taxes), because they never enter anyone's income. 2) Subtract corporate profits and add dividends, because corporations earn them and don't pay out either because they are retaining profits or are paying taxes to the government. 3) Government pays out in transfer payments, so add Government Transfer to Individuals and subtract Social Insurance Contributions. 4) We include the interest households earn rather than the interest that businesses pay. We add Personal Interest Income and subtract Net Interest. (the difference between them arises in part because the interest on government debt is part of the interest households earn rather than part of the interest businesses pay out.

How do households divide their disposable income?

Between consumption and saving.

Human capital (definition)

The accumulation of investments in people, such as education.

Write down national income accounts identity for closed economy.

Y = C + I + G, where NX = 0, so the term NX is absent from the equation.

Explain a category of GDP - Consumption

( C ) It consists of household expenditures on goods and services.

Explain a category of GDP - Government Purchases

( G ) They are the goods and services bought by i) federal, ii) state iii) local governments. Includes: military equipment, highways, services provided by government workers. Doesn't include: transfer payments to individuals, such as Social Security and welfare.

Explain a category of GDP - Investment

( I )It consists of items bought for future use. It has 3 parts: 1) business fixed/nonresidential fixed investment i) purchase by firms of new structures, equipment and intellectual property. 2) residential investment i) purchase of new housing by households and landlords 3) Inventory investment i) increase in firms' inventories of goods (if inventories are falling, inventory investment is negative)

Explain a category of GDP - Net Exports

( NX ) It accounts for trade with other countries. Net Exports equal: Exports - Imports. Net Exports represent the net expenditure from abroad on our goods and services, which provides income for domestic product.

Capital (factors of production definition)

(symbol K) The set of tools workers use. e.g. crane, calculator, PC

Labour (factors of production definition)

(symbol L) The time people spend working.

How to tackle income inequality?

- (treating symptoms, not the causes) more redistributive system of taxes and transfers. - Put more society's resources into education (human capital), aka Educational reform.

National Saving / Saving (definition) also give equations

- A nation's income minus consumption and government purchases; - the sum of private and public saving. S = Y - C - G = I S = Y - T - C + T - G = (Y - T - C) + (T - G)

Why is GDP an imperfect measure of economic activity?

- Because imputations necessary for computing GDP are only approximate. - the value of many goods and services is left out altogether

What 2 properties do many production functions have?

- Constant return to scale. - Diminishing marginal product.

Explain the effect of an increase in government purchases on economy.

- Economy's output and consumption are fixed; the increase in government purchases must be met by an equal decrease in investment. Y - C - G = I To induce the investment to fall, the real interest rate must rise. - In terms of circular diagram: government increases purchases from goods and services market without an increase in taxes. Public saving must decrease, since private saving remains the same, national saving decreases, which causes the investment to decrease. At the initial interest rate the demand for loanable funds exceeds the supply, so real interest rate rises to equilibrate the demand for loanable funds with supply of loanable funds.

How does GDP treat intermediate goods?

- GDP only includes the value of final good, because the value of intermediate good is already included as part of the market price of final good. - Alternatively, GDP is the total value added of goods at each stage of production. (Total value added of all firms in the economy.

Give examples of imputations in the economy

- Homeowners that live in their houses, pay the rent to themselves, so GDP includes the "rent" that homeowners "pay" to themselves. The Department of Commerce estimates what the market rent for a house would be if it were rented and includes that imputed rent as part of GDP. - Imputations also arise in valuing government services e.g. police officers, fire fighters and senators.

What happens at equilibrium interest rate?

- Households' desire to save balances firms' desire to invest, and the quantity of loanable funds supplied equals the quantity demanded. - demand for goods and services equals the supply.

Why is chain-weighted measure of GDP better than traditional?

- In more traditional methods the base year was updated every 5 years so that over time prices wouldn't become more and more dated. - In a new method the base year changes continuously over time. Therefore chain-weighted method ensures that prices used to compute real GDP are never far out of date.

Difference between flexible and sticky prices.

- Market-clearing model assumes all prices are flexible, however some wages and prices are sticky. Therefore, market-clearing model doesn't describe the economy at every instant, but they describe the equilibrium towards which economy gravitates. - Market-clearing model is hence a good assumption for studying long-run issues such as the growth of real GDP that we observe from decade to decade. - Many prices in short-term are fixed at predetermined levels, which makes the assumption of price flexibility less plausible. - Price stickiness is therefore a better assumption for studying short term behaviour of economy.

How does competitive firm maximise profit?

- Profit is a function of 1) product price, 2) workers' wage, 3) capital's rent 4) factor quantities of capital and labour. - In a competitive market product price, workers' wage and capital's rent are fixed/predetermined. Competitive firm can maximise profit by choosing the quantities of labour and capital in the production.

What do we use to measure economic well-being or economic satisfaction and why?

- Real GDP, because it varies from year to year only if the quantities produced vary. Ultimately a society's ability to provide economic satisfaction for its members depends on the quantities of goods and services produced.

When are investment projects profitable? How does interest rate affect the profitability?

- Return (the revenue from increased future production of goods and services) must exceed its cost (the payments for borrowed funds). - If the interest rate rises, fewer investment projects are profitable, and the quantity of investment goods demanded falls.

What changes the demand for investment?

- Technological innovation increases demand for investment. - Government encourages or discourages investment through the tax laws.

How much capital does the firm hire?

- The point at which the change in revenue is equal to the change in rental cost. (ΔProfit = 0) ΔRevenue - ΔCost = 0 P x MPK - R = 0 MPK = R/P.

How is economy's income distributed from firms to households?

- Total output is divided between the payments to capital and the payments to labour, depending on their marginal productivities. - Each factor of production is paid its marginal product, and these factor payments exhaust total output.

What explains increasing inequality in family incomes?

- change in factor shares between labour and capital. (capital's share was increasing over the decades) - The race between Education and Technology. Educational advancement slowed down, but technological progress kept its pace. (Goldin & Katz)

Give examples of things that no imputations are made for:

- meals cooked at home - values of goods and services sold in the underground economy.

What do macroeconomists examine?

- the role of saving in economic growth - the impact of minimum-wage laws on unemployment - effect of inflation on interest rates - influence of trade policy on the trade balance and exchange rate.

Show an improved circular flow model of dollars between markets, households, firms and the government.

...

- List 3 key differences between GDP Deflator and CPI. - How will increase in price of goods bought only by firms affect both? - How will Toyota produced in Japan and sold in UK affect both in UK?

1) i) GDP Deflator measures the prices of all goods and services produced. ii) CPI measures the prices of goods and services bought by consumers. 2) GDP only includes those goods produced domestically. CPI can include any good sold in the country. 3) i) CPI assigns fixed weights to the prices of different goods. The CPI is computed using a fixed basket of goods. It is a Laspeyres Index. ii) GDP deflator assigns changing weights to the prices of goods. The GDP deflator allows the basket of goods to change over time as the composition of GDP changes. It is a Paasche Index.

1) Core Inflation (definition). 2) Why is it a better gauge of ongoing inflation trends?

1) A statistic, which measures the increase in price of a consumer basket that excludes food and energy sectors. 2) Because food and energy prices exhibit substantial short-run volatility.

What is demand for goods and services? What is the supply?

1) Consumption + Government Purchases + Investment 2) The level of production

1) Private saving (definition) 2) Public saving (definition)

1) Disposable income minus consumption (Y - T - C) 2) Government receipts minus government spending; the budget surplus (T - G)

1) Why is MPL curve also the firm's labour demand curve? 2) Why is MPK curve also the firm's capital demand curve?

1) For any given real wage the firm hires up to the point at which MLP equals the real wage. 2) For any given real rental price of capital the firm buys up to the point at which MLK equals the real rental price of capital.

How is GDP (economy's output) allocated in closed economy?

1) Households consume some of the economy's output. 2) Firms and households use some of the output for investment. 3) Government buys some of the output for public purposes. Consumption + Investment + Government purchases

4 questions about sources and uses of nation's GDP.

1) How much do the firms in the economy produce? What determines a nation's total income? 2) Who gets the income from production? How much goes to compensate workers, and how much goes to compensate owners of capital? 3) Who buys the output of the economy? How much do households and firms purchase for investment, and how much does the government buy for public purposes? 4) What equilibrates the demand for and supply of goods and services? What ensures that desired spending on consumption, investment, and government purchases equals the level of production?

1) What does an increase in revenue from an additional unit of labour depend on? Give an equation. 2) What does an increase in revenue from an additional unit of capital depend on? Give an equation.

1) Marginal production of labour (MPL) and the product price. ΔRevenue = Product price x MPL 2) Marginal production of capital (MPK) and the product price. ΔRevenue = Product price x MPK

1) Average labour productivity (definition) 2) Average capital productivity (definition)

1) Output per worker, or Y/L 2) Output per unit of capital, or Y/K

List reasons why CPI overstates inflation.

1) Substitution bias. - Because the CPI measures the price of a fixed basket of goods, it does not reflect the ability of consumers to substitute toward goods whose relative prices have fallen. - Thus, when relative prices change, the true cost of living rises less rapidly than does the CPI. 2) Introduction of new goods. - When a new good is introduced into the marketplace, consumers are better off because they have more products from which to choose. - In effect, the introduction of new goods increases the real value of the dollar. Yet this increase in the purchasing power of the dollar is not reflected in a lower CPI. 3) Unmeasured changes in quality. - When a firm changes the quality of a good it sells, not all of the good's price change reflects a change in the cost of living. Many changes in quality, such as comfort or safety, are hard to measure. - If unmeasured quality improvement is typical, then the measured CPI rises faster than it should.

1) Accounting Profit (definition) 2) Give an equation for accounting profit

1) The amount of revenue remaining for the owners of a firm after all the factors of production except capital have been compensated/paid. 2) Accounting Profit = Economic Profit + (MPK x K)

Assumptions about factors of production in Chapter 3

1) The economy has a fixed/given number of capital and labour (it doesn't change over time). Also represented by an overbar. 2) Factors of production are fully utilised. (No resources are wasted)

Under which conditions is the economic profit of a firm zero?

1) The firm is competitive. 2) Profit maximisation is the target. 3) Production Function has the property of constant returns to scale.

What is Production Function? What does Production Function reflect?

1) The mathematical relationship showing how the quantities of the factors of production determine the quantity of goods and services produced, e.g. Y = F(K, L). (Y denotes output/goods and services) - Output is a function of the amount of capital and the amount of labour. 2) The available technology for turning capital and labour into output.

What does economy's output of goods and services (GDP) depend on?

1) The quantity of inputs, called Factors of production. 2) The ability to turn inputs into outputs, as represented by the production function.

Depreciation of capital (definition)

1) The reduction in the capital stock that occurs over time because of aging and use. 2) the amount of the economy's stock of plants, equipment, and residential structures that wears out during the year.

What are factors of production? Which ones are the most important?

1) They are the inputs used to produce goods and services. 2) 2 most important are capital and labour

1) Marginal Product of Cobb-Douglas function. (definition) 2) Give both equations.

1) To obtain marginal product of labour and marginal product of capital, we need to differentiate Cobb-Douglas function with respect to L and K respectively, so F(K,L) becomes MPL and MPK respectively. 2) MPL = (1-α)AK^(α)L(-α) MPK = (α)AK^(α-1)L^(1-α)

1) Give an equation for the distribution of total income of a firm. 2) How is the total income divided?

1) Y = (MPL x L) + (MPK x K) + Economic Profit. 2) Total income is divided among the return to labour, the return to capital, and economic profit.

1) Give an equation for the demand of goods and services in the economy in terms of real interest rate. 2) Why does real interest rate equilibrate the demand for supply of economy's output?

1) Y| = C(Y| - T|) + I(r) + G|, since Y, T, G are exogenous variables, demand for economy's output is dependent primarily on real interest rate. 2) Since consumption and government purchases cannot be altered to bring demand and supply of economy's output into equilibrium, investment can be altered by changing real interest rate. At equilibrium interest rate the demand for goods and services equals the supply. If real interest rate is too high, then investment is too low, so demand for output falls short of supply. If real interest rate is too low, then investment is too high, so demand exceeds the supply.

Describe the behaviour of Marginal Product of Cobb-Douglas function.

1) since MPK = αY/K and MPL = (1-α)Y/L, quantity of capital is inversely proportional to MPK, but directly proportional to MPL. 2) WLOG quantity of labour is inversely proportional to MPL, but directly proportional to MPK. 3) A technological advance A raises the marginal product of both factors proportionately, therefore is absent from the MPK and MPL formulas.

1) Give an equation for the change in profit from hiring an additional unit of labour. 2) Give an equation for the change in profit from buying an additional unit of capital.

1) ΔProfit = ΔRevenue - ΔWages = (P x MPL) - W 2) ΔProfit = ΔRevenue - ΔCost = (P x MPK) - R

What determines the quantity of output supplied in the economy and why? Why is economy's output fixed?

1)Factors of production and production function, because the output of economy is equal to the supply. Y = F(K|,L|) = Y| 2) It is because economy's output depends the quantity of capital and labour, which are fixed.

List and explain all 5 assumptions in chapter 3.

1. Ignored the role of money, the asset with which goods and services are bought and sold. 2. There is no trade with other countries (closed economy) 3. Labour force is fully employed. 4. Capital stock, labour force and production technology are fixed. 5. Ignored the role of short-run sticky prices.

A person who wants a job but has given up looking. (term)

A discouraged worker

What is a competitive firm?

A firm, which is: 1) small relative to markets, so has little influence on market prices. 2) The quantity of goods sold cannot increase or decrease their market price. 3) The firm cannot influence the wages of their workers, because many other local firms also employ workers. 4) The firm has no incentive to pay more than market wage, and it cannot pay less as workers would leave and somewhere else.

Gini coefficient (definition)

A measure of the dispersion in incomes.

Paasche price index (definition)

A measure of the level of prices based on a changing basket of goods.

Laspeyres price index (definition)

A measure of the level of prices based on a fixed basket of goods.

Employed (definition)

A person who at the time of the survey worked as paid employees, worked in their own business, or worked as unpaid workers in a family member's business. It also includes those who were not working but who had jobs from which they were temporarily absent. e.g. vacation, illness, or bad weather.

Not in the labour force (definition)

A person who is neither employed nor unemployed, such as a full-time student, homemaker, retiree or a discouraged worker.

Unemployed (definition)

A person who were not employed, were available for work, and had tried to find employment during the previous 4 weeks. It includes those waiting to be recalled to a job from which they had been laid off.

Consumption function (equation, definition)

A relationship showing the determinants of consumption; for example, a relationship between consumption and disposable income, C = C(Y - T). C = MPC(Y - T) + C', where C' is a minimum possible consumption with 0 dollars of disposable income.

Recession (definition)

A sustained period of falling real income.

Exogenous variable

A variable that a particular model takes as given; a variable whose value is independent of the model's solution

Endogenous variable

A variable that is explained by a particular model; a variable whose value is determined by the model's solution.

What is depreciation of capital?

Also called Consumption of fixed capital. It is a cost of producing the output of the economy.

GDP Deflator (definition)

Also called IMPLICIT PRICE DEFLATOR. It measures the price of output relative to its price in the base year. It reflects what is happening to the overall level of prices in the economy. GDP Deflator is used to deflate or take the inflation out of Nominal GDP to yield Real GDP

Open economy (definition)

An economy in which people can freely engage in international trade in goods and capital.

Inflation (definition)

An increase in the overall level of prices and fall in the purchasing value of money.

Constant return to scale (definition)

An increase of an equal percentage in all factors of production causes an increase in output of the same percentage. zY = F(zK,zL) for any positive number z.

Why is simplification a necessary part of a useful model?

Any model constructed to be completely realistic would be too complicated for anyone to understand. Yet if models assume away features of the economy that are crucial to the issue at hand, they may lead us to conclusions that do not hold in the real world. Economic modeling therefore requires care and common sense.

What property would production function need to have if it were to produce constant factor shares when factors always earned their marginal products?

Capital Income = MPK x K = αY Labour Income = MPL x L = (1-α)Y, where α is a constant between 0 and 1 that measures capital's share of income.

CPI (definition)

Consumer Price Index - a measure of the overall level of prices that shows the cost of a fixed basket of consumer goods relative to the cost of the same basket in a base year.

Explain the effect of decrease in taxes on the economy.

Decrease in taxes by ΔT causes disposable income to rise by the amount ΔT and the consumption to rise by ΔT x MPC. Since government purchases and economy's output remains fixed, an increase in consumption must be met by a decrease in investment. For investments to fall the real interest rate must rise. Hence, the reduction in taxes, like an increase in government purchases crowds out investment and raises the interest rate. - National saving falls by the same amount as consumption rises, so a drop in national savings decreases the supply of loanable funds, which increases real interest rate and crowds out investment.

Disposable Personal Income (equation) What is it?

Disposable Personal Income = Personal Income - Personal Taxes. Disposable Personal Income is the amount households and non-corporate businesses have available to spend after satisfying their tax obligations to the government.

Closed economy (definition)

Economy that does not engage in international trade. (Net exports [NX] are always zero).

Show the role of exogenous and endogenous variables

Exogenous as input runs through a model and endogenous variable is the output.

Cobb-Douglas Production Function. (definition)

F(K,L) = AK^(α)L^(1-α) , where A>0 is a parameter, that measures the productivity of the available technology.

Explain neoclassical theory of distribution.

Factor prices equal the marginal products of the factors of production. Because marginal products depend on the quantities of the factors, the change in quantity of any one factor alters the marginal products of all the factors. Therefore, a change in the supply of a factor alters equilibrium factor prices and the distribution of income.

How do governments encourage or discourage investment through the tax laws?

Government can increase personal income taxes and use the extra revenue to provide tax cuts for those who invest in new capital. Such a change in tax laws makes more investment projects profitable and increases the demand for investment goods.

Government's Balanced budget (definition)

Government purchases equal taxes minus transfers, then G = T and government has balanced budget.

Public saving (definition)

Government receipts - government spending. Any excess of tax revenue over government spending. Budget surplus if positive, Budget deficit if negative.

GDP (definition)

Gross Domestic Product - the total income of everyone in the economy - the total expenditure on the output of economy's goods and services. - market value of all goods and services produced within an economy in a given period of time.

GNP (definition)

Gross National Product - the measurement of total income produced by nationals. - The total income of all residents of a nation, including the income from factors of production used abroad; the total expenditure on the nation's output of goods and services. GNP = GDP + Factor Payments from abroad - factor Payments to Abroad

Diminishing marginal product (definition)

Holding the amount of capital fixed, the marginal product of labour decreases as the amount of labour increases. WLOG holding the quantity of labour fixed, the marginal product of capital decreases as the amount of capital increases. - Assuming ceteris paribus, marginal product of labour is inversely proportional to the quantity of labour. - Assuming ceteris paribus, marginal product of capital is inversely proportional to the amount of capital.

How does GDP treat inventories?

If a firm pays wages to create a product, but fails to sell the product, there are 2 possible scenarios: 1) If a good is lost, the firm paid more in wages, but didn't receive additional revenue, so the firm's profit is reduced by the same amount that wages have increased. The total expenditure hasn't changed, therefore GDP stays the same. 2) If a good is put into the inventory, the transaction is treated differently. The firm's profit stays the same even though it paid more wages. This increase in income for workers and increased expenditure by firm raises GDP. 3) When the firm sells a good later, this is the same as a used good. The negative spending by firm offsets the positive spending by consumer, so GDP stays the same. ***This treatment ensures that GDP reflects the economy's CURRENT production of goods and services.

What is Euler's Theorem? (production function)

If production function has constant returns to scale, then F(K,L) = (MPK x K) + (MPL x L) - To prove this we need to differentiate zY = F(zK,zL) with respect to z to obtain Y = F1(zK,zL) x K + F2(zK,zL) x L where F1 and F2 denote partial derivatives with respect to the 1st and 2nd arguments of the function. Evaluating the expression at z = 1, and noting that the partial derivatives equal the marginal products, yields Euler's theorem.

What does Cobb-Douglas Production Function imply about average productivity? Why?

If the function is Cobb-Douglas, the marginal productivity is proportional to its average productivity. Because MPL = (1 - α) x average labour productivity. MPK = α x average capital productivity

What is the link between real wages and labour productivity?

If the market is competitive, then MPL = W/P, also MPL = (1 - α) x average labour productivity, therefore: Real Wage = (1 - α) x average labour productivity. Real wages are directly proportional to average labour productivity.

What does "crowding out" mean?

Increase in government purchases causes the interest rate to increase and investment to decrease.

Producer Price Index (definition)

Index, which measures the price of a typical basket of goods bought by firms rather than consumers

National Income (definition)

It measures how much everyone in the economy has earned. National Income = NNP - Statistical Discrepancy

Nominal GDP (definition)

It measures the current dollar value of the output of the economy.

Real GDP (definition)

It measures the economy's output at constant prices from base year. It reflects what's happening to the overall level of quantities in the economy.

Where does art of economics lie?

Judging when a simplifying assumption clarifies our thinking and when it misleads us.

Problems with Laspeyres and Paasche indices.

Laspeyres Index tends to overstate the increase in the cost of living, when prices are changing by different amounts, because it doesn't take into account the consumers' ability to substitute less expensive goods for more expensive ones. Paasche Index tends to understate the increase in the cost of living, because it does not reflect the reduction in consumers' welfare that may result from substitutions of less expensive goods for more expensive ones.

Explain national income identity

Let GDP = Y, Consumption = C, Investment = I, Government Purchases = G and Net Exports = NX. Y = C + I + G + NX.

MPK (definition) Give an equation in terms of Production Function.

Marginal product of capital - the amount of extra output the firm gets from 1 extra unit of capital, holding the amount of labour constant MPK = F(K + 1,L) - F(K,L)

MPL (definition) Give an equation in terms of Production Function.

Marginal product of labour - the amount of extra output produced when the labour input is increased by 1 unit. - The extra amount of output the firm gets from 1 extra unit of labour, holding the amount of capital fixed. MPL = F(K,L + 1) - F(K,L)

MPC (definition)

Marginal propensity to consume - the amount by which consumption changes when disposable income increases by one dollar. 0 <= MPC <= 1

What is the "profit" described in national income accounts under the assumptions of competition, profit maximisation and constant returns to scale? Why?

Mostly return to capital, because most firms own rather than rent the capital they use, so firm owners and capital owners are the same people.

How do national income accounts divide national income into components?

NIA divide National Income into 6 components based on who earns the income. 1) Compensation of employees - the wages and fringe benefits earned by workers. 2) Proprietors' income - the income of noncorporate businesses, such as small farms, mom-and-pop stores, and law partnerships. 3) Rental income - the income that landlords receive, including the imputed rent that homeowners "pay" to themselves, less expenses, such as depreciation. 4) Corporate profits - the income of corporations after payments to their workers and creditors. 5) Net interest - the interest domestic businesses pay minus the interest they receive, plus interest earned from foreigners. 6) Taxes on production and imports - certain taxes on businesses, such as sales taxes, less offsetting business subsidies. These taxes place a wedge between the price that consumers pay for a good and the price that firms receive.

NNP (Definition)

Net National Product - the total market value of all final goods and services produced by the factors of production of a country during a given time period, minus depreciation. It shows the net result of economic activity. NNP = GNP - Depreciation.

Give an equation linking together Real GDP, GDP Deflator and Nominal GDP.

Nominal GDP = Real GDP x GDP Deflator

Unemployment rate (definition)

Percentage of the labour force that is unemployed.

Labour force participation rate

Percentage of the population that is in the labour force.

PCE deflator

Personal Consumption Expenditures deflator - the ratio of nominal consumer spending to real consumer spending. It only focuses on consumption part of GDP.

Personal Income (equation). What is it?

Personal Income = Dividends + Government Transfer to Individuals + Personal Interest Income - Indirect Business Taxes - Social Insurance Contributions - Corporate Profits - Net Interest. It is the amount of income that households and non-corporate businesses receive.

Flexible prices

Prices that adjust quickly to equilibrate supply and demand.

Profit of a firm (equation)

Profit = Revenue - Capital costs - Labour costs = P x Y - W x L - R x K As Y is a function of L and K, Profit = P x F(K,L) - W x L - R x K.

What are services?

Services include different intangible items that consumers buy. e.g. haircuts, doctor visits.

Similarities of PCE deflator with GDP deflator or CPI.

Similarities with CPI: - includes only the prices of goods and services bought by consumers. - excludes the prices of goods and services that are part of investment and government purchase. - includes the prices of imported goods. Similarities with GDP deflator: - Is also a Paasche Price Index as the composition of consumer spending changes.

List examples of intellectual property.

Software, research, development, entertainment, literary and artistic originals.

Why does technological innovation increase the demand for investment?

Suppose a new concept is invented. Before a firm or household can take advantage of the innovation, it must buy investment goods. Hence demand for investment increases.

What alters the Production Function? Why?

Technological change, because if someone invents a better way to produce a good, the result is more output from the same amounts of capital and labour.

What is statistical discrepancy? Why does it arise?

The amount by which figures differ. It arises because different data sources may not be completely consistent. This is a small correction by which NNP and NI differ.

Factor Prices (definition)

The amounts paid to each unit of the factors of production.

What did Paul Douglas notice about the economy in 1927?

The division of national income between capital and labour had been roughly constant over a long period.

How much labour and how much capital does a competitive firm need to hire and buy respectively for profit maximisation. (simple rule)

The firm demands each factor of production until that factor's marginal product falls to equal its real factor price.

Loanable funds (definition)

The flow of resources available to finance capital accumulation.

Economic profit of owners of the firm (definition). Give an equation.

The income that remains after the firms have paid the factors of production. Economic profit = Y - (MPL x L) - (MPK x K) where *Y* is total income of a firm.

What does the quantity of investment goods demanded depend on?

The interest rate

Interest rate (definition)

The market price at which resources are transferred between the present and the future; the return to saving and the cost of borrowing.

Sticky-price model

The model of aggregate supply emphasizing the slow adjustment of the prices of goods and services.

market-clearing model

The model which assumes that prices freely adjust to equilibrate supply and demand. - the price of any good is found at the intersection of demand and supply curves.

Real interest rate (definition)

The nominal interest rate corrected for the effects of inflation.

Real wage (definition)

The payment to labour measured in units of output rather than in dollars.e.g. W/P is a real wage.

Real rental price of capital (definition)

The rental price measured in units of goods rather than in dollars.e.g. R/P is real rental price of capital.

Effect of used goods on GDP

The sale of used goods is not included as part of GDP, because GDP only measures the value of CURRENTLY produced goods and services. Therefore transfer of assets doesn't add to the economy's income.

Labour force (definition)

The sum of employed and unemployed.

Exports (definition)

The value of goods and services sold to other countries.

Imports (definition)

The value of goods and services that foreigners sell us.

What do we assume about the link between consumption and disposable income?

There is an indirect linear relationship between consumption and the level of disposable income. A higher level of disposable income leads to greater consumption.

What does "seasonally adjusted" statistics mean?

This means that the data have been adjusted to remove the regular seasonal fluctuations.

Some goods and services are not sold in the marketplace and therefore do not have market prices. How does GDP include them?

We must use an estimate for their value or their imputed value/imputation.

When are imperfections in GDP most problematic?

When comparing the standards of living across countries.

national income accounting

a system that measures GDP and collects macroeconomic statistics on production, income, investment, and savings

underground economy (definition)

economic transactions that are hidden in order to evade taxes or conceal illegal activity.

What are goods?

goods are tangible items that are subdivided into durables and non-durables. 1) durables last a long time. e.g. cars, TV. 2) non-durables last a short time e.g. food, clothes.

Real (adjective, definition)

measured in constant dollars; adjusted for inflation

Nominal (adjective, definition)

measured in current dollars; not adjusted for inflation

Nationals (definition)

residents of a nation